Nest Eggs

November 30, 2010

Don’t depend only on your bank if you want to shop for any financial product. Do your homework and choose a good advisor tooI was at my bank for some work. At the next table, a pretty young 20-something (PYTS) was sitting tight-lipped, anxious and eager. She was from the bank.

Across her was a client (an NRI, since he had his passport, etc, with him and had that NRI look) who was trying to fill up a form. My ears perked up when I heard familiar words like ‘NAV’, ‘SIP’, ‘Guaranteed’, etc. The PYTS was explaining:“Sir, you can choose seven years or fifteen years.”Client: “What if I want to discontinue?”PYTS: “Sir, if you pay for at least five but make it seven, you will get the highest NAV.”Client: “What if I stop after five years?”PYTS: “Then you will not get highest NAV. Seven years and you get highest NAV.”Client: “Less than five years?”PYTS: “Then you won’t get highest NAV.”

The conversation went along these lines as the client filled up the form, sorted out issues regarding adding his newly-wedded spouse’s name to the account, etc. As the client finally affixed his signature, the relief for the PYTS was obvious. Fortunately for her, the client was engrossed in something else, so the PYTS merely exchanged a conspiratorial grin with an assistant who was holding the papers.

One more ULIP (unit-linked insurance plan) sale notched up. I got speaking to my relationship manager and asked about the PYTS. Found out that she had gone through an ‘intensive’ one-week course on insurance.

Of course, she had not passed any exam to sell mutual funds or insurance. My relationship manager mentioned that only one person from the branch had cleared the exams, but everyone was selling. Each relationship manager had a stiff target on selling non-banking products. He said that ULIPs were the preferred ones, since they fetched the highest commissions.

Also, clients were easy on ULIPs as opposed to mutual funds. The bank’s staff does not offer any mutual fund product unless the client asks for it. Selling is restricted to insurance products. And, naturally, they don’t ‘sell’ term insurance. ULIPs are the way to go. Once in a while, when the associate fund house launches a new fund offer (NFO), the relationship managers get targets on those. Apart from that, there is no effort to sell mutual funds.

Of course, the one exception is the systematic investment plan (SIP). The relationship manager said that they push this because most clients are happy to have three to four accounts in SIPs of equity mutual funds. Here, he said that the preferred push is based on schemes the asset management companies (AMCs) are making available at a particular point in time. Upfront commission is important. The bank is not bothered about trail commissions. It does not give any credit to the employee for trail commission the bank may net!

To me, the eye-opener was the refusal of the bank to give credit for ‘trail’ commission to its employee! In the ‘golden’ days for the distributor, upfront commissions used to be 2%-3% (excluding the NFOs for which it used to be 6%). Trail commissions for equity schemes used to be 0.5% per annum. Today, upfront commission has come down to anything between 0.5%-1.5% and the trail commission is going up to 1% per annum. To earn the same level of upfront commissions, the sales guy has to sell three to four times the amount of funds.

The distributor’s thrust on upfront commission leads to employees churning the same asset over and over again. This mangles the client’s returns, but the sales guy is not bothered with that. For him, his monthly salary and commission are the driving force.

As a result, the distributor is not able to build on his total asset base, since he will lose the client and the employee at some time. And, with the client gone, the trail commission will disappear as well, since the market regulator Securities and Exchange Board of India (SEBI) has mandated that when a client moves away from a distributor, neither the old nor the new distributor gets the trail commission. A number of sales employees I have talked to say that they understand this, but the pressure to perform overwhelms most of them. They not only end up losing clients, but also end up being forced to change jobs.

Is there a better alternative to this state of affairs? There has to be a realisation among all concerned that a selling agency will get paid 1% per annum as all-inclusive revenue from the producer. They have to charge the customer separately for advice. Yes, the client will be a reluctant payer, but he has to come around. It is possible that this structure will make all distributors and independent financial advisors (IFAs) focus only on clients with a certain minimum level of financial assets. So, the small investor will be left to the fly-by-night operators and suffer.

Or he has to get financially savvy and do his own thing, which is virtually impossible, given the fact that he is unlikely to acquire the skills or have the time to understand complex products like ULIPs.

The best way is for the investor to become more financially aware. Spend time on understanding the products and their risks. And, understand that there is no free lunch. Choose a good advisor and pay him/her a fair sum for advice. The times are changing. The sooner you realise it, the better. Otherwise, you will be a victim of mis-selling at the hands of those who you think you can trust—your bankers.

AMCs & Their Strange Ways

Large distributors (euphemistically called ‘channel partners’) submit large applications of high networth individuals (HNIs) which do not comply with the requirements that ordinary mortals have to comply with. Only their PAN (Permanent Account Number) card copies are provided.

No address proof is given. The address given in the form is a ‘care of’ address of the distributor! This practice has been maintained by AMCs, since it is these large distributors who run the game.

Distributors fear that once the details get into the domain of the registrar & transfer agent (RTA), the AMC and competing distributors would get hold of the addresses and contact the clients directly. There is clearly an issue of uniformity in compliance.

SEBI had directed that until there is compliance in full, AMCs cannot pay distribution commission on these investments. Substantial sums are involved and distributors have been pressuring AMCs to release their commissions.

AMCs cannot afford to displease the distributors. Some have paid the amounts from the AMC itself, while the fund schemes have not yet been debited. AMCs have tried to use the AMFI (Association of Mutual Funds in India) route to get this commission payments released, but a couple of times that AMFI recommended the release on some pretext or the other, the regulator came down heavily.

The compliance deadlines are at hand. For over a year, since the regulator first notified AMCs for compliance, there has been no progress. Now the industry is seeking an extension for compliance (just means completing the address and contact details). The regulator is sitting firm on its deadline. In case of non-compliance with the directives, AMCs are likely to be penalised heavily. Fund houses have a dilemma on their hands. Once again, this is an example of the hold that the large distributors have on fund houses who simply cannot afford to have their own distribution network in place.